AOL reboots 10 years after Time Warner merger, with a bold bet on content

The AOL Time Warner merger of 2000 created a $160 billion colossus that fused America Online, the dominant Internet-access business of the 1990s, with Time Warner, the traditional media mammoth. But in a decade rocked by two recessions, Web access gave way to messaging, search and advertising -- and upstart Google (GOOG) overtook the merged company as the world's biggest Internet giant. On Wednesday, nearly a decade after what some critics jeered as the worst corporate merger ever, AOL (AOL) -- DailyFinance's parent company -- will once again become a stand-alone public corporation, spinning off from Time Warner (TWX) in an independent public offering on the New York Stock Exchange. This time around, AOL CEO Tim Armstrong is making a bold bet on content -- and the stakes couldn't be higher.

World-Class Content

Once it goes public, AOL's market capitalization will be about $2.6 billion: roughly 1% of the AOL Time Warner market value at its peak. The new company's shares, which have traded on a "when-issued" basis since Nov. 24, closed at $23.50 on Tuesday afternoon.

Under Armstrong, a veteran Google ad executive who took over as CEO in March, AOL's new focus will be to provide world-class content and to offer marketers a sophisticated way to sell ads against that content. That may be an uphill battle. "AOL is a company with significant challenges ahead, in all of its business segments," wrote Ben Schachter, an Internet analyst at Broadpoint AMTech, in a note to clients Tuesday that expressed skepticism about AOL's "niche-at-scale" content and ad strategy.

Schachter believes the stock price will fall before it rises. He initiated coverage of the new company with a $25 price target. "We recommend investors wait for a more compelling entry point," he wrote.

You've Got Mail!

In the mid-1990s, under CEO Steve Case, AOL seemed on top of the world, surpassing rivals CompuServe and Prodigy as the top Internet-access business. The AOL e-mail alert -- "Welcome!...You've got mail!" -- was so famous, it became the title of a Tom Hanks-Meg Ryan romantic comedy. As the millennium approached, the Internet revolution was in full swing. Young entrepreneurs started companies in their dorm rooms and garages, and quickly spun them off for millions. The climate of Web-fueled optimism sent the stock market soaring.

Naturally, the major old-media companies wanted a piece of the action. When storied media-entertainment conglomerate Time Warner merged with AOL, the move was seen as a victory for the old guard as well as the new, and the two generations were supposed to combine in a forward-looking, new-millennium media juggernaut that would deploy Time Warner's rich content assets over AOL's network. "We've transformed the landscape of media and the Internet," declared an exultant Case at the time.

But the media and Internet landscape had already begun transforming. Even as Case and Gerald Levin, who had engineered the merger from the Time Warner side, were celebrating, two former Stanford students were busy building the company that would indeed transform the Net. Within a few short years, Google's search engine and ad business came to dominate the Web.

Search and Destroy

Very early on, Google co-founders Sergey Brin and Larry Page determined that the advent of broadband Internet access through cable and high-speed DSL lines would destroy AOL's business of providing snail-paced dial-up access. For Google, the Internet wasn't about how you connected -- broadband, they knew, would soon solve that problem on a wide scale -- but what you did once you got online.

Creating a giant index of all the world's Web pages would make Google the Internet's de facto home page: to advertisers, a highly attractive proposition. Users, after all, were coming to Google because they're looking for something -- and often, to buy something. What's more, those users were telling Google exactly what they were looking for. Marketers jumped at the chance to target advertising so specifically. As Google ascended, AOL's glory days became a memory -- and its Time Warner merger increasingly looked like a bad move.

By late 2005, AOL Time Warner's market capitalization had dropped so precipitously -- from $220 billion to $20 billion -- that Google was able to buy a 5% stake for $1 billion. And that massive decline was a harbinger; Google this year sold its AOL stock back to Time Warner for just $283 million, but kept control of the company's search function.

As the first decade of the century drew to a close, AOL had become synonymous with the "old" Internet, a 20th-century relic to a generation of plugged-in Web users. The next generation of Net giants -- first MySpace, then Facebook and Twitter -- connected users through giant social networks and let them communicate in real time. Twitter in particular seemed to represent something wholly new. Millions of users flocked to it to broadcast sudden, 140-character thoughts about everything from that plane landing on the icy Hudson River, just beyond their office window, to what they ate for breakfast that morning. And AOL's time had passed -- or so it seemed.

The Whole World Is Watching

This fall, as its IPO neared, AOL has faced intense scrutiny from the skeptical media and analyst corps. Despite Armstrong's success in building Google's ad business, some observers openly doubted he could turn around the beleaguered AOL. But Armstrong says he didn't join the company for the money -- his years at Google had made him very wealthy -- but rather for the challenge. Although AOL's brand remained powerful around the world, Armstrong says, its businesses need streamlining. AOL had to decide what kind of business it would become.

Armstrong has made a countertintuitive bet, pushing AOL's chips firmly in the direction of content. Just as traditional news companies are laying off thousands of reporters and editors, AOL is scooping lots of them up for its network of nearly 100 Web sites. And it has unveiled plans for Seed, an online application that will let qualified users create content based on popular subjects and get their articles published online.

"There is significant upside potential if AOL can just get its advertising margins more in-line with its peers," Broadpoint's Schachter wrote. "However, with audience loss headwinds from the continued declines in the access subscribers and accelerated declines overall in its key AOL properties (homepage, mail, AIM), coupled with our skepticism of the 'niche-at-scale' strategy, we simply think it may be a long wait before overall margins might improve."

If Armstrong can turn AOL around, he'll have completed a Herculean task -- a victory possibly sweeter than the millions he made at Google. Of course, the consequences of failure could be dire for AOL shareholders and employees.

If ever there was a test of that old Internet bromide, "Content is king," this is it. Will Armstrong's embrace of that philosophy pay off for the company he's leading into the next decade? The marketplace will render the verdict.